The Labour Party’s plans to create a public-owned TOC has been condemned by the rail industry

The East Coast rail business is again proving a magnet for controversy. Last month, shadow transport secretary Mary Creagh announced a new policy commitment of transforming Directly Operated Railways from the government’s operator of last resort into a vehicle to bid for rail franchises.

Creagh’s argument was based on DOR’s record of returning over £1bn of premium payments to government between taking over the service from the failed National Express East Coast franchise in November 2009 to its scheduled return to the private sector in 2015. She also railed at the ability of European
state-owned businesses to win UK franchises while the UK’s public-sector business is unable to bid for contracts (PT084).

“We think it ludicrous that state railways in France and Germany and the Netherlands are operating British franchises but the law is geared up so our own British state operator can’t bid and we want to change that,” Creagh told a meeting of the all-party parliamentary rail group last month.

It drew one of the most concerted hostile reactions from the rail industry to any prospective policy announcement.

The Rail Delivery Group denounced the creation of a “pointless” public versus private sector debate as a distraction from real issues of investment and improving service quality. “Holding up publicly-run East Coast as a model of how to run a better railway is a myth that is wrong,” RDG chairman Martin Griffiths said. Privately, train operators seethed over the apparent misrepresentation of East Coast’s record (see panel). They also expressed concern over the impact on fair competition from another state-owned bidder with access to cheaper government borrowing, particularly one backed by a mandate to bring franchises back to UK government ownership.

Labour’s announcement is yet to be fully fleshed out in terms of how DOR would bid and the franchises it would bid for. Nonetheless, if quasi renationalisation is the purpose, many in the industry believe Labour would be fighting an ideological battle that has already been largely won albeit by default, following the Office of National Statistics’ reclassification of Network Rail as a public sector organisation.

“Labour seems to be looking at opinion polls suggesting nationalisation of the rail industry could be a good thing and thinking it needs a policy response,” one senior franchising advisor to a number of private sector bidders told Passenger Transport. “Their answer could be that the really important part of the railways – covering safety and direct control over the majority of costs – is effectively nationalised now. Franchising under the current system is really about customer service. At a philosophical level, isn’t that the part you would privatise while nationalising control over safety, rather like the bus network in London?”

However, arguably, the most remarkable aspect of the announcement is not its implications for the UK rail sector but an apparent reversal under successive governments of any colour that the UK public sector should not be involved in competitive markets.

“If they are saying they want to create a commercial vehicle that may be better placed to bid for foreign franchises (as well as UK contracts) than the private sector that’s an intriguing question, but it goes against the grain of British industrial policy going back 30 years,” the bid advisor commented. “There may be some national benefit from putting the UK balance sheet into play to ensure the Germans and French don’t run away with everything, but I’m not sure that’s a legitimate public policy goal.”

While the true intent is as yet unclear, there is little doubt that transforming DOR into a bid vehicle would be a major undertaking and present a number of issues. DOR’s current remit as operator of last resort is very different to the one starting to be mapped out by Labour.

UK rail franchises are the world’s largest public transport operating contracts and bid teams have up to 50 full time professionals. Would DOR attract skilled resource in competition against established bidders?

And what would its prospects of winning be? Some are sceptical that DOR’s record would even provide it with the necessary qualifications to be shortlisted to bid, potentially requiring a loosening of policy to enable it to do so. In addition, Labour has implied that intercity businesses would be a priority. Yet this is the only sector where European state-owned companies are yet to have any success in winning contracts. One possible reason is that these are the franchises where the private sector’s willingness to take commercial risk and offer entrepreneurial nous is at starkest contrast with the public sector’s core skill of railway management capability. In 2012, the bids for the aborted West Coast franchise showed that Virgin and FirstGroup were well ahead of their state-owned rivals, Abellio and Keolis/SNCF, perhaps reflecting the different heritage of the businesses involved.

“Public sector organisations behave in a territorial way – they are interested in acquiring railways and expanding empires which is costly and can be perceived by the private sector as unfair competition,” one senior industry consultant commented. “But on West Coast it is likely they had a more conservative view of revenue growth which is probably an argument in favour of the private sector [operating these types of long distance franchises].”

A further consideration Labour has yet to address is the risk DOR would face. With bids for intercity operations costing around £12m and bids for other franchises at least half that sum, large quantities of public sector money would be at stake. Historically, new entrants have needed several bids before winning a franchise. Danish state rail DSB submitting five unsuccessful bids for UK rail franchises, costing an estimated £25m, before giving up. If DOR failed to make an impression quickly it could lead to uncomfortable scrutiny from the National Audit Office and Public Accounts Committee.

If DOR were to win, experience on the East Coast and Cross Country franchises shows operation of intercity businesses can incur losses many times the considerable bid costs. In addition, performance bonds worth tens of millions of pounds must be provided as financial security, tying up further public funds.

“DOR would be needing to make the case for funds that could be allocated with less risk to other areas of government responsibility,” Passenger Transport was told. “If I was a DfT minister, I would be very nervous turning up at the Treasury and saying, have I got a deal for you! We’re going to be bidding for franchises at around £10m a time, if we win there is risk involved and, by the way, we are tying up £50m a time in bonds. Oh, and we’ll be destroying DOR’s ability to act as operator of last resort as well because we can’t guarantee to have the resources available for that and to run franchises too.”

Sources familiar with DOR’s structure also believe that UK government requirements for the DOR chief executive and the secretary of state for transport to act as accounting officers responsible for proper use of public funds may place further constraints.

“So there are funding issues, issues in attracting skilled resources and real political accountability issues,” said a political consultant with detailed knowledge of the DfT. “But most fundamentally there is an issue of how to ensure a level playing field and perceptions that it is level.

His concerns relate not only to the possibility that the process could be manipulated for political purposes, but an institutional bias in the DfT in favour of public sector ownership.

“Are you telling me, with the best will in the world, that a Labour secretary of state will be briefed by their officials that, on a franchise the government has stated it wants DOR to win, a competitor has a stronger bid?” he commented. “How do you avoid the political fix or at least the perception of it? Chinese walls are in place but people are only human. It’s also a fact that a significant slug of people in DfT are ex-Strategic Rail Authority and previously ex-British Rail, never believed in privatisation and still don’t.”

While Labour’s policy is widely regarded as “ill-thought through” from several angles, a number of senior rail industry consultants, as opposed to operators, have some sympathy with the party’s stance of at least starting to consider the objectives of rail policy.

“Labour seems to think the rail industry is in the private sector, whereas in fact the current structure [and franchising system] is really one of costly public control. So to carry on about East Coast and DOR is to miss the point and shows they probably don’t understand the issues,” one senior consultant commented. “On the other hand the government doesn’t seem to have a policy at all – seriously what have they done? … What matters is effective management and organisation of the industry, and that’s where the policy debate needs to be.”

 

Prejudice dominates DOR debate

The prejudices that accompany debates over the benefits of public and private sector ownership are apparent in the way different sides have portrayed DOR’s performance, particularly comparison with its predecessor NXEC and the other major intercity operation Virgin Trains.

Labour and the unions have made play of the £200m per year premium that East Coast now returns to the government, while Virgin West Coast returned £108m in 2012/13.

However, Virgin’s lower premium reflects the investment which has gone into the route and the accompanying rise in rolling stock lease costs and track access charges. In 2012/13, Virgin paid £302m to lease trains on average nine years old, while East Coast paid £53m for trains on average three times older.

Modernisation of the East Coast service when intercity express trains are introduced is expected to have a significant impact in reducing the premium East Coast pays due to the rise in leasing costs.

In addition, comparisons with the £100m premium paid in the last year of the NXEC franchise fail to reflect the rebasing of track access charges. In a statement to parliament last year, transport secretary Patrick McLoughlin said NXEC paid £210m a year in access charges compared to £92m by East Coast.

From an operational perspective, under DOR, East Coast is now the least punctual long distance operator and train operators have also been critical of East Coast’s record in modernising working practices. “The industrial relations environment is old school in terms of structuring terms and conditions, maintenance costs are old school and would be more familiar to a British Rail manager than anyone else,” one industry source commented.

Yet, these issues were not addressed by private sector predecessors either. And DOR explains the lack of strategic action as a consequence of repeated deferral of plans to refranchise the
East Coast business.

East Coast’s performance is a poor, perhaps irrelevant, means of judging the merits of public and private sector ownership.

 

This article appears inside the latest issue of Passenger Transport.

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